A hike in policy rates and a low rupee can be a ‘deadly’ combination – Opinion
Five global central banks, including the State Bank of Pakistan, will make political announcements this week. The other four are the Bank of Japan (BoJ), the Bank of England (BoE), the Federal Reserve (FED) and the Swiss National Bank (SNB).
Interest rate decisions are sure to have a profound impact on the financial market, especially in the current situation where inflation is climbing like a monster due to the abundant emergency stimulus supply being provided to fight the pandemic. . Russia, Brazil, Turkey, the Czech Republic and Mexico have already raised their rates earlier. South Korea was the first developed economy to do so in August this year, while others are considering withdrawing stimulus support.
However, two major global central banks, the BoJ and the European Central Bank (ECB), have made their intentions clear; they have already announced that inflation is transient due to the Covid-19 factor.
This week, the other four central banks (CBs) are expected to take a cautious stance as well, and can wait and watch, as the threat of the delta variant probability stretching and spreading has risen sharply.
But the Fed’s action will be closely watched as it may not raise interest rates in September; it is the size of the Fed’s tapering that would count and give a clue to the future direction of interest rates. Delaying its quantitative easing will put the doves on its back, potentially delaying the rise in U.S. interest rates until 2023, unless inflation gets out of hand. In other words, it is the taper and its size that will provide the clue.
Pakistani monetary policy announcement
It will be too early for SBP to become hawkish; it should still wait until the 1st quarter of 2022, because the next 6 months are very crucial for the Pakistani economy. SBP’s message through its latest policy announcement has been clear about maintaining an accommodative stance. More importantly, SBP’s new forward-looking monetary tool is very clear on the future direction and therefore we are not yet close to raising the policy rate.
How is it possible that SBP is making a preemptive hike when inflation is within its target range? It is a fact that despite the pressures caused by rising global commodity prices, CPI inflation has been fairly contained so far.
Any premature tightening will threaten the recovery. Although the economy is growing in some areas, pressure on the balance of payments position is intensifying despite extraordinary support from remittances and much needed stimulus from donors. Employment conditions are not keeping pace with population growth.
In the current situation, the SBP is expected to send a message first, then take a neutral stance before doing anything. The banking system is already congested and in difficulty, which is why the SBP is forced to extend its sterilization action (use of its monetary tools) to manage its cash flow by successfully using several heads (domestic / external inputs) – tools that have also been used by previous governments in the past. Unlike in the past, however, we are now on the FATF gray list. There is no doubt that the SBP is using its monetary tools effectively, but at the current rate it may have peaked.
Adding to the problem is the spillover factor caused by the unrest and unstable conditions in Afghanistan. It is important to note that the rise in commodity prices globally has nothing to do with our domestic demand. Food inflation is due to weakness / flaws, which are caused by policy failure. A relatively complacent approach to the agricultural sector is purely an administrative matter. Wheat can be harvested twice a year and sugar twice over an 18-20 month period. The rice that is planted in May-June is harvested between October and December. Our policymakers will need to realize that real growth is sluggish and that the economy still requires expansionary policies. Therefore, any increase in policy rates in the presence of a weak rupee can become the cause of destabilization. Our fragile economy demands softer financing with more room for recovery.
(The writer is the former national treasurer of Chase Manhattan Bank)
He tweets @asadcmka
Copyright Business Recorder, 2021